Clients Should Ask Their Advisor This Simple Yes or No Question
Over the past year, investors have been receiving notifications about the U.S. Department of Labor’s fiduciary rule that would have impacted financial advisors and their clients. Simply stated, the DOL’s new “fiduciary duty” standard would have required financial professionals who receive compensation for transactions to act in their client’s “best interest.”
Well, the U.S. Fifth Circuit Court of Appeals struck down the Labor Department’s new fiduciary rule and issued a mandate saying that the agency exceeded its authority in promulgating the rule. So, the Fiduciary Rule is dead (at least for now).
Why it was Defeated
The DOL’s rule and related exemptions would have required all retirement advisors – whether fee- or commission-based – to adopt and practice a fiduciary standard that puts their clients’ best interests first and foremost. And retirement advisors would have had until 2018 to acclimate to this new fiduciary rule.
According to the National Law Review, the final rules would have likely impacted broker-dealers the most, Registered Investment Advisors the least, and with insurance companies somewhere in the middle. “Record-keepers who have insurance companies or mutual fund manager affiliates will be impacted more than independent record-keepers. And, while not directly affected by the new rules, mutual fund management firms need to understand their impact, for example, the needs of broker-dealers in this new environment.”
The new rule would have meant that financial advisors – for the first time – would have had to provide full transparency around the fees and commissions they charged for retirement plan advice and products. And illustrating the importance of fees and how small differences can add up, the DOL even provided the math:
“A percentage point lower return could reduce savings by more than a quarter over 35 years. In other words, instead of a $10,000 retirement investment growing to more than $38,000 over that period; after adjusting for inflation, it would be just over $27,500.”
It’s Really Not That Complicated
While the U.S. Securities and Exchange Commission has expressed interest in creating its own fiduciary rule, the reality is that it was authorized to create one when the Dodd-Frank Act was passed in 2010. In other words, investors should not count on the government to adopt what seems like a very common-sense rule.
Instead, investors should ask their financial advisor this one simple question:
“As my financial advisor, are you always acting in my best interest?”
If your advisor answers with a “no,” try this follow-up question for fun:
“If you weren’t always acting in my best interest, whose best interest were you acting in?”
And then run away.
Questions to Ask
Investors might be well served by asking these questions:
- Are you a fiduciary? Fiduciaries act only in your best interest.
- Are you fee-only? Fee-only advisors are compensated only by you, the client.
- What is the range of fees and commissions you might receive? Here are some fees to ask about: investment management fees (minimize); mutual fund expense ratios (minimize); transaction fees (minimize); mutual fund sales loads or charges (avoid); commissions on annuities and other products that he/she is selling (avoid); redemption fees (avoid); and 12-1b fees (avoid). Fee-only advisors do not work on commissions. Also, fiduciary advisors have procedures in place to make sure that their client fees are reasonable.
- Do you promise to act in my best interest on all matters related to advice and investment recommendations for my retirement portfolio? This is the definition of fiduciary.
- Do you or your firm have any potential conflicts of interest with decisions you might make on my behalf? For example, does the advisor sell annuities, which have very lucrative commissions. Or, does the advisor recommend frequent portfolio turnover, which generates transaction fees and commissions.
- Do you use index funds? If not, why not? Decades of evidence has shown that disciplined, low-cost investing using a diversified portfolio of index funds improves the odds of investment success.
- What is your approach to investing? Evidence-based or conventional? A conventional approach relies on stock-picking and market-timing to outguess the markets. No on has a crystal ball. These strategies only guarantee high fees and commissions. Instead, an evidence-based approach relies on data and reasoning to improve your odds of investment success in the long term.
These questions will undoubtedly lead to more questions and the more you are informed, the better off you’ll be.